You are on page 1of 23

Aerospace and Defence

Manufacturing in India
Transformation in sight
January 19, 2011
4th ASSOCHAM International Conference on Indian Defence

19 January, 2011 Hotel Shangri La, New Delhi

2
About Aviotech

Aviotech is an initiative of the promoters of the Deccan Chronicle


Group to address the segments of Corporate Aviation and Defense
& Aerospace Advisory and Investments. Its operations are spread
across India and UK and has offices in Hyderabad, Delhi and
London.

Aviotech aims to provide its clients with information that empowers


them to take informed decisions. It aims to support the initiatives of
its clients through structured financial advice and guidance.

Deccan Chronicle Group has interests across Media, Financial


Services, Retail, Information Technology, Aviation and Defence &
Aerospace.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 3


Foreword

India remains very much one of the most attractive business


destinations in the world. It continues to enjoy the benefits of a
growing economy, large domestic demand, young population and
stable government policies coupled with a maturing investment
structure and a strong legal system.

India’s Defense and Aerospace manufacturing opportunity is a


function of its ability to emerge as a cost-efficient manufacturing
and service destination in this segment.

While the journey towards India emerging as a global Defense and


Aerospace manufacturing base has already commenced in the right
earnest, it will have to be supported in equal measure by the
translation of the requirements of the OEMs by domestic industry
as well as by a supportive government policy.

While specific initiatives like offsets that are expected to act as a


catalyst to the aforementioned process, the drive will emerge from
the unwavering focus on inherent cost and quality parameters that
Indian manufacturing has displayed in other industrial sectors.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 4


India - An attractive destination to do business with
witnessing increasing global interest in the A&D segment

In times when the world economy is barely recovering from its


sternest test, India’s $1.3 trillion economy grew by 8.9 per cent
through the first six months of fiscal 2011. This when looked at in
the light of sustained performance witnessed in the period between
2006 – 09 of 9.5% lends extreme credibility to the India story.

In the first six months of 2011, The manufacturing sector, which


grew at almost 10 per cent. This pace of growth was achieved
alongside strong performance in the agricultural
sector, strengthening consumer demand and a robust services
sector.

India has been a key destination for global defence contractors as a


defence market. It is one of the top defence spenders in the world.
Global defence spending is dominated by the United States which
accounts for more than 40% of global defence spend. India has the
tenth largest defence spend in the world. In 2011, India's
expanded its defence budget by 3.98 per cent to Rs. 1,47,377 Crore
(1 Crore = INR 10 Million) representing 2.12 per cent of gross
domestic product (GDP). Of this, approximately 40 percent finds
allocation under capital expenditure and equipment modernisation
programmes. Since the current levels of indenisation are
anticipated to be around 40%, a significant outlay is towards
global procurement.

More significantly, India’s defence spend as compared to some


other countries, has been expanding over time at a reasonable rate.
It is anticipated that for the period 2011-2015, Indian military is
expected to spend more than $80 billion on acquisitions with the
Indian army having a largest contribution >50% followed by the
Indian Airforce and the Indian Navy. Capital expenditure is expected
to grow at 10% per annum for the period which is significantly
positive as compared to other global economies.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 5


With a growing civil aviation market, Indian companies have been at
the forefront of demand generation for aircraft manufacturers. An
example is found in the single largest order for Airbus in early 2011
which came from an Indian airline operator.

The Civil Aviation market in India is growing at a compound annual


growth rate (CAGR) of 18% and it is anticipated that the Indian
aviation sector will become one of the top five civil aviation markets
in the world over the next five years. Currently, India ranks ninth in
the global civil aviation market. Boeing anticipates a requirement of
1,150 commercial aircraft for India worth US$ 135 billion in the next
20 years.

All of the above makes India a destination of choice for global


defence and aerospace contractors to have a manufacturing and
delivery presence in.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 6


Why the interest in Indigenous defence and aerospace
manufacturing and service delivery capabilities?

The interest in Indigenous defence and aerospace manufacturing


capability stems from both push and pull factors. These factors are
a combination of attractiveness of India as a cost-efficient + high-
quality manufacturing and service delivery destination, a strong
policy push through the introduction of offsets as well as an
expressed business opportunity provided by both homeland
security projects and large opportunities under the ‘Make’ and ‘Buy
and Make – Indian’ category.

Attractiveness of India as a
cost efficient, high quality Work coming to India
manufacturing and service due to regulatory
delivery destination constraints in other parts
of the world.
Example : Engineering
Design, Sheet metal work, Example : Some types of
Specialised forgings surface treatment

Pull Factors
Increasing interest in Indigenous defence and
aerospace manufacturing and service delivery

Push Factors
Strong government policy impetus through
Focussed offset policy Buy and Make-Indian’ and A large homeland security
initiative requiring the global ‘Make’ Projects which opportunity being driven
defence contractor to invest have a minimum by significant government
in the development of stipulation of indigenous initiatives
indigenous defence and content / value add.
aerospace manufacturing
capability

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 7


Evolution of the Defence and Aerospace manufacturing
industry in India

Indian aerospace and defence manufacturing has historically been


dominated by the government owned and managed Defence
Public Sector Undertakings (DPSUs), Public Sector Undertakings
(PSUs) and the Ordnance Factory Board.

The manufacturing segment in India has followed a slightly different


path of evolution and market structure from elsewhere in the
world. While globally, Defense and Aerospace manufacturing has
grown in a tier-ed structure with the OEM at the top of the
pyramid, followed by the tier-1 suppliers who do large portions of a
programme, who in-turn are supported for smaller portions of their
contribution to the programme by Tier-2 and Tier-3 manufacturers
and finally the component manufacturers at the bottom of the
pyramid. Simplistically represented, this rather neat structure
provides clear flows of work-share liability downwards upwards
while allowing for contribution to flow downwards

The Indian experience on this particular aspect is slightly different


with historically the DPSUs / PSUs and OFB participating in the
entire value chain – commencing from an integrator level right
down to the Tier-3 suppliers / component manufacturer level
thereby leaving little room for private sector capabilities to develop.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 8


This has also resulted in a very dispersed presence of DPSUs across
the value chain which has been a factor for their not being in a
position to address all the parts of the value chain in terms of
research and technological edge.

It can be argued that such a model of growth has been an outcome


of larger national policies and interests, however the end result is
that this model did not allow private Indian industry to play a
meaningful role in this sector.

With the increasing cost and technology specialisation related


product development pressures, DPSUs and PSUs are now under
justifiable pressure to restrict their role to that of an integrator
thereby allowing for larger work-share to private sector, the tier-1
and tier 2 space has emerged as a vacant space that private
industry is trying to fulfill.

This entire process is also supported by the creation of offset


driven demand for the products which will be produced by private
sector Tier-1 and Tier-2 manufacturers.

All of this presents a significant opportunity for Indian


manufacturing capability to emerge in this sector however it has
also resulted in constricted existing capability of the industry to
absorb demand being created by Offsets and the government
impetus on ‘Buy and Make-Indian’ and ‘Make’ projects.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 9


Defence and Aerospace manufacturing and service
delivery capabilities in India : Key themes

India’s existing capabilities in Defense and Aerospace provide for a


basic framework for the absorption of work-share.

To assess the framework, we reached out to a large number of


companies comprising OEMs, Global Tier-1 and Tier-2 suppliers and
Indian manufacturers. The result of these interactions was the
emergence of some key themes that govern the manufacturing and
service delivery framework for Defense and Aerospace industry in
India.

These themes were then collated and grouped together under


broad categories of Industrial Capability, Infrastructural Support,
Policy Impetus and Human Resources.

We present these key themes and a broad assessment of them


below:-

Wide spread across a large base, yet limited depth of segments


Industrial
Strong capabilities in Engineering Design, Existing pockets of excellence in some other segments
Capability
Limited capabilities in materials sciences

Creation of Defense and Aerospace oriented SEZs


Infrastructural
Strong existing legal and Intellectual property (IP) frameworks
Enablers
Evolving financial framework to support Industry

Articulated and announced Defence Production Policy


Policy
Rapidly evolving Offset policy
Impetus
Stated emphasis on ‘Buy and Make-Indian’ and ‘Make’

Human Capital Limited but expanding Human capital availability

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 10


Industrial Capability

The existing supply chains of DPSUs and Ordnance factories


comprises thousands of suppliers, most of whom are component
level suppliers. The worrying perspective on this front is that most
of these suppliers are small enterprises – thereby with limited
capacities.

At the same time, it must also be mentioned that the Medium and
Small Scale Segment of suppliers also includes suppliers who
operate niche technologies and processes, thereby making them
valuable.

With limited existing capacities and few suppliers for each specific
product/component – the total available Industrial base is rather
limited in depth. This creates issues vis-à-vis the ability to absorb
relevant work-share either from the Offsets or from large
indigenous projects.

However this assessment varies significantly with each service.


While the Navy has achieved a significant level of indigenization
with the development of local manufacturing sources, the same
cannot be said about the Air-force and the Army.

Another pertinent aspect of this assessment is the limited progress


Indian industry has made on material sciences. This limitation is
seen across speciality metals and alloys, composites and man-made
fibres as well as specific reagents for treatment. A case in point is
elaborated on the composites business where Indian capability in
the private sector has still not evolved in the precursor and fibre
segment.

In our interactions with the various OEMs, we got a brief glimpse of


what they are currently looking at sourcing from India. A corollary
to this can be that these capabilities are present in a limited space
in the private sector in India.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 11


Industrial Capability Map – Snapshot

Defence Defence Defence


Manufacturing Manufacturing Manufacturing
(Land Systems) (Naval Systems) (Aerospace)
 Platforms  Platforms  Aerostructure Manufacturing
(Defence and Civil)
 Engine Assemblies  Galley Equipment Significant
 Forgings
 Gearboxes and Transmissions  Engines  Cables, Connectors and Engineering Design
 Chassis Manufacturing  Simulators
Assemblies capability across
 Castings land, systems,
 Wheels and Tracks  Boilers
 Simulators naval systems, air
 Armouring and Protection  Gear Boxes and Transmissions
Solutions
 Composite Structures systems and C41
 Cabling  Ground Support / Ground applications
 Radio Communication Handling Equipment
 Piping
 Ammunition and fuzes  Precision Engineering
 Ropes and Pulleys
 Tyres  Rubber Components
 Communication Systems
 PCBs and Electronic
 Rubber Components Assemblies
 Pumps
 Hydraulics
 Winches
 Fabrication C4I Applications
 Heavy Engineering  Hydraulics (Control Surfaces)  Command and
 Deck Equipment Control electronics
 Seats and Interiors  Electrical Motors
 Platform Management  Data links
 Fasteners
 Lights Systems  Multi-layered PCBs
 Sheet Metal Work
 Harnesses and Cabling  Heavy Engineering  Embedded systems
 Communication Systems
 Composite Structures  Navigation Systems  Basic communication
 Testing Equipment
suites
 Electrical Busses and Controls  Rigid inflatable boats
 Avionics components
 Control Electronics  Electricals
 GIS solutions
 Testing  Simulators
 Prototyping
 Simulators

The above chart collates from the responses of various OEMs and
Indian companies, their impressions on the broad spread of
industrial capability in India. The depth of each sub-category may
vary significantly and hence the above map provides a rough
assessment of the market capability set.

It must however be stressed that across the board, there was


sustained and significant appreciation of India’s strengths in
Engineering design – a segment where India is recognized as a
global player.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 12


Infrastructural Enablers

The government has created dedicated Special Economic Zones


dedicated to Defense and Aerospace. With this, a long-term need
has come closer to fruition as the Special Economic Zones (SEZs)
enable export oriented businesses to leverage significant
policy, economic, structural and procedural benefits – all of which
enable a more cost effective product / service delivery.

However the complete integration of the Special Economic Zones


(SEZs) with the relevant Ministry of Defence policies and procedures
has still not been completed. This if completed, can bring significant
advantage of Indian aerospace and defence manufacturers vis-à-vis
global competition.

India also enjoys a very robust legal regime and this when coupled
with India’s strong insistence on protection of intellectual property
provide comfort to OEMs transferring sensitive know-how and
know-why.

A major hurdle towards the development of India as a defence and


aerospace manufacturing hub is the lack of financing options for the
MSME segment of the Industry. The cyclic nature of this industry
and long gestation periods until product stabilization and
acceptance put significant financial pressures upon entrepreneurs
wanting to leverage the opportunity. It is usually noted that a
significant number of Medium and Small Scale Industries in this
industry find raising capital from conventional sources extremely
difficult. The new Defence Production Policy announced in 2011
does take its first steps in this direction by explicitly referring to the
setting up of a fund to support initiatives, however it may not be
enough. The industry has also started seeing its first wave of
consolidation with larger groups paying a premium for specific
niche capabilities in the MSME sector. It is anticipated that this
wave of consolidation will strengthen over the near term because
of the need of large players to quickly deploy specific capability in
segments where large project opportunities are available.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 13


Policy Impetus

The Indian experience with Offsets began in Ernest in 2006. The


policy finds its genesis in the need to develop a robust industrial
base for self-reliance. Offsets are an opportunity for India to
integrate with the global Defense and Aerospace supply chain. A
significant amount of matter is available on the Offset policy and
hence it is not delved-in detail in this paper. The only points to
make are that the Defence Procurement Procedures (DPP 2011) by
opening up the offsets spectrum to items of civil aerospace
(including raw materials and work-in-progress items) and homeland
security has enabled Indian industry to create more compelling
business cases for OEMs to source from. There are however some
issues that require deeper attention – these being the interlinked
issues of Transfer of Technology and Multipliers.

In January 2011, the government has also introduced the Defence


Production Policy which for the first time outlines the vision and
focus of the government towards developing Indigenous
manufacturing and service bases. The policy for the first time talks
of a Defence Manufacturing Ecosystem and aims to integrate the
various players in this frame, including the SME segment of
industry.

The policy has extremely forcefully put forth the strong impetus on
developing manufacturing sources in India through a combination
of targeted procurement from Indian companies, allowing Indian
companies preference in the upgrades, Assessing capabilities of
Indian companies while drafting SQRs and trying as far as
possible, to undertake design and integration of platforms within
the country.

While there is a strong push on policy, its implementation will be


watched very carefully especially on the initiatives related to the
development of an indigenous manufacturing base – spread over
both DPSUs and the private industry.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 14


Human Resources

The human capital base for this industrial segment to expand in the
proportion desired and anticipated, requires severe augmentation.
Traditionally the sources of engineering talent for Defense and
Aerospace in India were few and the skills imparted to students
were far from current. Over the past few years, there has been a
sudden increase in the number of institutions offering specialised
engineering degree programmes in this segment however the
demand continues to far outstrip the supply. Aside from
volume, the quality of Defense and Aerospace engineering talent
from institutions has to be upgraded significantly. A sustained
shortfall in quality entry-level engineering talent has the potential
to derail the growth of this segment. To overcome this possible
scenario, some OEMs have established linkages with Institutions
and are actively contributing in making their curriculum relevant as
also assuring themselves of a steady supply of human capital.

Another risk to the industry emanates from the lack of mid-to-


senior level managerial talent which can oversee the significant
expansion anticipated in the Industry. Conventional sources of
talent have been the DPSUs. While there is no ready solution to this
problem, the issue is being tackled by OEMs and Indian companies
looking at both expatriate Indian populace as well as foreign
nationals to come and fill this gap.

An issue that has sensitivities associates with it and which is faced


by the industry and the Services is the exodus of talent in the
Armed forces to the industry which is providing a viable solution to
the talent gap.

Mid -level
Entry level talent Top executives
executives

Addressing the Gap


Addressing the Gap
Addressing the Gap
• New institutions / New
courses • Services
• Expatriates
• Industry Tie-ups with • DPSUs/PSUs
• International Talent
Academia • Other industries
• Services

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 15


Some key issues before the industry

Limitation of liability on the OEM :

The OEM stands behind the design and quality of its products and
services by the express warranty provisions of the contract.
However, the current Defence Procurement Procedures are silent
regarding the allocation of risk between the buyer and the seller in
the area of 1) Post-delivery product loss and 2) special damages
(also referred to as consequential and incidental damages).
Limitation of liability for post-delivery product loss and special
damages is a common feature in commercial and military contracts
in most nations across the world.

As the OEM does not hold title to the platform or manage the use
of the platform after delivery to the Government of India or the
Armed forces, the current policy forces the OEM to obtain
prohibitive insurance to cover the risk of post delivery loss which is
passed back to the government as a component of the price bid.
Special damages also referred to as consequential and incidental
damages, are liabilities typically not borne by the OEM. It is
impossible to assess exposure to such loss and damage as special
damages by their nature are remote, unquantifiable and
uninsurable. The potential liability for special damages can be
astronomical and grossly disproportionate to the economic benefit
received by the OEM from the sale. Without the appropriate
allocation of risk in a contract, the OEM could be entering into a
contract, which threatens the financial health of its OEM far beyond
the benefit obtained in a single contract action. In short, when the
OEM offers goods and services to a Customer on a “best value for
money basis” its offer is calculated on the basis that it will not be
exposed to loss of use, loss of profit or other special damages.

It is critical for the solution of the above issue by incorporation of


appropriate liability limitations that places the risk on the party that
best controls the elements of risk and is best able to manage it.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 16


Licensing, Manufacture and Export of Defence products.

A key issue with the current environment for Defense and


Aerospace manufacturing concerns the definition of Defence
Product. Currently the DIPP defines Defence products in a different
manner as is defined in the DPP for offset purposes. The DPP 2008
and subsequently DPP 2011 did take a step forward from the DPP
2006 with a definition of the Defence Products for the purpose of
Offset. It is important to have a standard understanding of what
constitutes a Defence Product (especially when dealing with dual-
use items) from the DIPP perspective as well. It is imperative at this
juncture to look at some western countries like the US which have
harmonised their systems and work on a standardised Munitions
List.

This problem also manifests itself with the requirement of an


Industrial Licence for defence products when the latter itself is not
clearly specified. The issue is further complicated by lack of a clear
definition of Defence and Aerospace products in the Indian Trade
Classification- Harmonised System (ITS-HS). This issue assumes
criticality as only after that the current export procedure for
Defence Products (a significant part of which are governed by
SCOMET guidelines) has been rationalised with the population of
category 6 of the SCOMET list and the ITC-HS, can a true
assessment of Industry be made and transparency in policies
ensured.

FDI

Manufacturing of defence equipment in India is subject to a 26%


cap on FDI. A 26% cap on FDI discourages original equipment
manufacturers (OEMs) from bringing in proprietary technology.
Another fallout of the low FDI cap is that this could possibly result
in limiting the foreign capital inflows into the sector and thereby
increases the corresponding fund requirements of the Indian
partners. The argument against raising the FDI cap to more than
26% stems from the fear of Indian companies ceding control and
thereby resulting in units that can be closed in situations of
operational need of the armed forces rendering a disruption in the
supply chain. The FDI issue is a key determinant to the interest of
Foreign OEMs in developing India as a manufacturing base.
ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 17
Outlook
The various issues do create a complex situation to assess Indian
Defense and Aerospace manufacturing and service delivery
capability. However the response of the industry segment to all the
industry forces and policy initiatives is best reflected in tangible
performance shown.

Indian industry over the past few years has shown the ability to
respond effectively to the market opportunity, especially in the
global market. There can be no better indicator of this than an
assessment of Aerospace exports as a testimony to this fact.

Indian Aerospace Exports over the last ten years can be very neatly
summarised into two phases – A first phase until 2006-07 and a
second phase of the subsequent period. The first phase of 2001
until 2006 which saw stagnant, lacklustre performance with exports
virtually stagnant and ranging between INR 223.57 Cr. (Crore) in FY
2004-05 and INR 407.73 Cr. in FY 2001-02. The Aerospace Exports
were also not displaying any significant growth indicating a less than
healthy state of the industry. The export performance witnessed in
this period was largely driven by export actions of DPSUs like HAL
and BEL. The period from 2006-07 onwards sees a rapid expansion
in this activity indicating a strong focused industrial expansion of
the sector. The levels of exports rose significantly from INR 350.02
Cr. in FY2006-07 to INR 2775.01 Cr. in FY 2007-08 indicating a jump
of 692% on a YoY basis further to INR 6697.32 Cr. in FY 2008-09
indicating a jump of 141% on a YoY basis

The significant increase in both the quantum and rates of growth of


Aerospace exports from 2006-07 onwards can be ascribed to two
specific reasons. The first reason is an increasing number of global
OEMs establishing dedicated centres for manufacture and supply in
India. Examples include Goodrich for landing gear and Thales and
Rolls Royce for engine components. The second significant reason is
widely believed to be the introduction of Defence Offsets which
have resulted in a large number of OEMs intently looking at India as
a destination for development of long term supply bases.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 18


The aforementioned example only proves that India has the
potential to emerge as a preferred Defense and Aerospace
Manufacturing and service delivery destination.

For the Indian industry, its journey towards being an integral part of
the global supply chain has only commenced. The path ahead is
tough, however the intent appears well-set.

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 19


Glossary of terms

DPP Defence Procurement Procedures

DIPP Department of Industrial Policy and Promotion

DOFA Department for Offset Facilitation

DPSUs Defence Public Sector Undertaking

FDI Foreign Direct Investment

INR Indian Rupees

MoD Ministry of Defence

OEMs Original Equipment Manufacturers

OFB Ordnance Factories Board

PSUs Public Sector Undertakings

SEZ Special Economic Zone

ToT Transfer of Technology

Key Metrics

1 Crore 10 Million (1,000,000) ~ USD 222,222.22

(Assumed Exchange Rate 1USD = 45 INR)

1 Lakh 100 Thousand (100,000) ~ USD 2222.22

(Assumed Exchange Rate 1USD = 45 INR)

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 20


Notes

ASSOCHAM-Aviotech Report on Defense and Aerospace Manufacturing in India 21


Defence Advisory
Investments INDIA :

Rahul Gangal
Director - Defence Advisory & Investments
Rahul@Aviotech.com

India Sewa Corporate Tower, Sector 25, MG Road, Gurgaon 122002


UK 31A - St James`s Square, London SW1Y 4JR

www.aviotech.com